How to understand the term sheet

By Sprouter, SprouterNovember 20, 2012

If you’re pitching investors to raise capital for your business, chances are you’ll encounter a term sheet during the process. Sprouter.com’s experts share their insight on what a term sheet covers, and what to do when you get one.

What are the important things to look for when negotiating a term sheet?

The valuation and the capitalization assumptions are the most important economic piece:

1. How much will the investor own post-investment and what does that include in terms of an available option pool?

2. What is the liquidation preference — this impacts how the money flows when you sell the business and subtle differences can have a big impact — ideally you want a 1X preference with no participation.

3. Governance terms such as the board composition and contractual covenants that give your investors control over matters such as selling the company or doing a new round of financing.

— Ivan Gaviria, partner, Gunderson Dettmer

Should I go into an investor meeting with a term sheet drawn up?

I don’t think so. Investors will have their own term sheets. You should have a sense of what terms you want when it comes to valuation, etc. Educating yourself on term sheets and how investors operate is absolutely critical because entrepreneurs are at a disadvantage in the process.

Investors invest for a living, they know exactly what they’re doing, what terms they want, how to structure deals, etc. Entrepreneurs do it very rarely (even serial entrepreneurs), so educate yourself on the legal issues, term sheet and deal structures and go in as prepared as you can be.